Adding a dollar of fund administration revenue tends to add about a dollar - or often even more - of cost, meaning administration costs are growing in parallel with revenue.
Those cost reductions that have occurred have largely been demanded by funds, rather than by suppliers as we have seen, for example, in the cloud industry.
These costs are eating into everyone's pension pots, but the fund industry has a prime opportunity to upgrade operational mechanisms and deliver better returns for investors.
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Previously, fund administration would typically be bundled up with other services, relying on custody and more lucrative niches like FX, cash balances, securities lending, and collateral management to subsidise the function.
But as funds become more discerning, those services are coming under scrutiny themselves and institutions are losing tolerance for 'carrying' fund administration. In this investment landscape, no longer can the fund industry accept these costs as a given.
Spark a little change
The time is right to put fund administration under the microscope and initiate a positive change. Operational processes have indeed come under increasing scrutiny in recent years, with resilience at all levels - whether it is technology, operational, or systemic - high on the agenda.
But the dislocation that has characterised recent months has sparked a mindset where businesses are more accustomed to new processes and are therefore open to ideas.
Operational teams have been at the heart of successful adaptation, and many have had to break their own internal rules for critical functions over the course of the pandemic.
For instance, during the extreme volatility and volumes of spring 2020, we have heard of teams having to circumvent internal NAV and fair value processes to deliver something workable and continue operations.
As such, there is a growing recognition that old structures are not always fit for the future.
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Some national financial authorities have been proactive in incentivising a solution to rising costs. In Australia, the Australian Securities and Investments Commission has exerted pressure on funds to improve efficiency.
And it is clear to see why: research into superannuation funds from the country's Productivity Commission found that retail funds charge about 0.5% in administration fees, which it estimates shrinks a retirement savings by 12% over a lifetime.
Recognising a similar problem, the authorities in India have put a cap on costs funds can charge the end investor, but still cannot get costs under control.
Genuine transformational efficiency
Until now, funds have addressed the problem by shaving off costs through tactics such as offshoring. But these savings have had their impact, and you can only achieve so much through incremental change.
The only route forward is through genuinely transformational efficiency. The manual processes involved in working from fragmented technologies and spreadsheets remain desperately inefficient and the manpower inflates costs.
But to plug the cost leaks, firms may have to look beyond traditional automation. The focus on consolidation of funds in markets such as Australia and Canada has created an impetus to look at the challenge of scalability more holistically and to collaborate where it makes sense.
Now that line of thinking should trickle into operations to create strategic partnerships that genuinely transform efficiency.
We believe the next few years will see firms begin to lose their traditional squeamishness about breaching the corporate boundary and consider an industry-wide approach. The future of fund operations almost certainly lies in having some degree of industry-wide infrastructure that caters to a broad spectrum of all operational needs.
Only then will funds be able to drive down costs and optimise returns.
Ultimately, the pandemic has opened up thinking about operational systems and market connectivity, and we can expect more scrutiny of cost leaks from both funds and regulators. That said, we cannot expect a leap forward with individual firms running on existing systems.
It is time for an industry-wide approach to innovation to propel the industry into a more profitable era.
Published by Investment Week.